How to Form an LLC With S Corp Election in Texas

Key Takeaways

• An LLC with S Corp election in Texas can help reduce self-employment tax and enhance credibility while retaining operational flexibility.
• To elect S Corporation status, LLCs must file IRS Form 2553 and meet certain IRS requirements like having no more than 100 shareholders.
• Texas-based LLCs do not need to convert into corporations to be taxed as S Corps.
• State-specific considerations include no franchise tax for many qualifying S Corps and straightforward maintenance requirements.
• Additional steps include meeting IRS deadlines, understanding Texas-specific filing fees, and maintaining compliance through annual reports.
• Legal and tax advisors can provide tailored support to ensure accurate filings and compliance.

Electing S Corporation Status for a Limited Liability Company

An S corp election for an LLC, or limited liability company, is an option when a business owner prefers to form a limited liability corporation but wants the beneficial tax treatment of an S corporation. Otherwise, an LLC is treated as a partnership by the IRS and is subject to self-employment tax on income from the business. While an S corporation is still treated as a pass-through entity, the income is taxed at the lower corporate rate. Electing S corporation tax treatment for your LLC is often the best option for active businesses or those who are subject to high payroll taxes. 

Both an S corporation and an LLC offer limited liability protection. This means the owners' personal assets are protected from business debts and legal judgments. An LLC is easier to manage and administer than an S corporation and offers more flexibility in distributing profits and losses to the owners. However, an S corporation allows owners to be paid either through distributions or with salaried wages. This entity also provides taxation benefits over an LLC.

Choosing whether to form an LLC or an S corporation requires determining the priorities for your business.

Understanding the S Corp Election Process for Texas LLCs

Electing S Corporation status for your LLC in Texas involves a federal tax classification change—not a state entity conversion. This means your LLC remains an LLC at the state level while being treated as an S Corp for federal tax purposes. Here’s what the process generally looks like:

1. Ensure Eligibility:
   • Must be a domestic entity.
   • Have no more than 100 shareholders (including individuals, estates, and certain trusts).
   • All shareholders must be U.S. citizens or residents.
   • The LLC must issue only one class of stock (although LLCs technically don’t issue stock, ownership interests must align with IRS rules).
2. File IRS Form 2553:
   This must be filed within 2 months and 15 days of the start of the tax year in which you want the S Corp status to take effect. Late filings may still be accepted if there’s a reasonable cause.
3. Confirm with the IRS:
   After submission, the IRS will send a CP261 Notice confirming your election. Keep this for your records.
4. No Texas State Election Needed:
   Unlike in some other states, Texas does not require a separate state-level filing to recognize the federal S Corp election.
5. Tax Year Selection:
   If you want a tax year other than the calendar year, include IRS Form 8716 (Election to Have a Tax Year Other Than a Required Tax Year).

Benefits of Forming an LLC

An LLC is a state-governed business entity that combines the limited liability of a corporation with the tax and operational benefits of a general partnership or sole proprietorship. As with a corporation, an owner's personal liability only extends to his or her investment in the business. By default, an LLC is treated as a pass-through taxation entity. This means the owners report business profits and losses on their individual tax returns. This prevents the double taxation experienced by corporation owners. An LLC is not recognized as a separate taxation entity by the IRS.

An LLC is easier to manage than a corporation since it is subject to fewer required:

• Filings
• Forms
• Formal meetings
• Record submissions 

An LLC is also less costly to start than a corporation. Unlike with a corporation, profit-sharing is not restricted for an LLC. This means you can distribute income without considering capital contribution percentages. 

LLC owners receive self-employment income, taxed at 15.3 percent for Social Security and Medicare. A single-member LLC is taxed as a sole proprietorship by default, while a multimember LLC is treated as a partnership by default. If you prefer to be taxed as a corporation, file Form 8832 (Entity Classification Election). You can then opt to be taxed by an S corporation by filing Election by a Small Business Corporation, Form 2553.

Considerations Specific to a Texas LLC with S Corp Election

For business owners operating in Texas, an LLC with S Corp election provides some unique advantages and considerations:

• No Personal Income Tax:
  Texas does not levy personal income tax, which means shareholders only pay federal taxes on distributions.
• Texas Franchise Tax:
  While Texas does charge a franchise tax, many small businesses fall under the “No Tax Due” threshold (currently $2.47 million in annual revenue as of 2024). Even if your LLC elects S Corp status, you may not owe franchise tax.
• Low Filing Fees:
  Texas has relatively low startup and maintenance costs compared to other states. The filing fee for a Certificate of Formation is $300.
• Simple Ongoing Compliance:
  Texas does not require annual reports for LLCs, though businesses must file a Public Information Report and a Franchise Tax Report annually with the Texas Comptroller.

Benefits of Forming an S Corporation

If you elect to create an S corporation, all income, losses, deductions, and credits from the business will be reported on your federal tax return and taxed at your individual rate. This minimizes your business's tax liability, since only wages paid to owners and employees are subject to Medicare and Social Security Tax (FICA). Other earnings are considered dividends. Another benefit of an S corporation is the limited liability it provides its owners. 

However, an S corporation must be based in the U.S. and have no more than 100 shareholders, excluding family members of each owner, who together count as one shareholder. An S corporation may not have the following as shareholders:

• Corporations
• Partnerships
• Nonresident aliens

However, estates, individuals, and certain types of trusts are permitted. An S corporation can issue a single class of stock, which can contain both nonvoting and voting shares. Some types of financial institutions, international sales corporations, and insurance companies are not eligible to form S corporations. 

S corporations are also subject to complicated administrative requirements, including:

• Additional filings and forms
• Formal meetings
• Official recordkeeping, which includes meeting minutes, bylaws, and written resolutions 

Unlike in an LLC, S corporation profits must be distributed proportionally to each member's ownership share. However, the ability to pay owners regular wages provides some flexibility and income distribution.

Tax Advantages of an S Corp Election for LLCs in Texas

Electing S Corp status allows LLC owners to split income between salary and distributions, potentially reducing self-employment taxes. Here's how that works in Texas:

• Salary vs. Distributions:
  Owners who actively work in the business can pay themselves a reasonable salary (subject to FICA taxes), and take the rest of their earnings as distributions (which are not subject to self-employment tax).
• IRS Scrutiny:
  Ensure your salary is “reasonable” based on industry standards to avoid IRS audits or reclassification of distributions as wages.
• Avoiding Double Taxation:
  While standard corporations face double taxation (corporate tax plus shareholder tax), an S Corp’s pass-through structure means only the shareholders are taxed on profits.
• Qualified Business Income (QBI) Deduction:
  S Corp owners may qualify for a 20% deduction on pass-through income under Section 199A of the Tax Cuts and Jobs Act—if eligibility criteria are met.

Combining the Benefits of an S Corporation and LLC

You can establish an LLC as the legal entity for your business but opt to be treated as an S corporation for taxation. This combines ease of administration with the ability to minimize your business's tax liability.

Step-by-Step: How to Elect S Corp Status for a Texas LLC

To create an LLC with S Corp election in Texas, follow these steps:

1. Form Your LLC with the Texas Secretary of State:
   • File Form 205 (Certificate of Formation).
   • Designate a registered agent with a Texas address.
   • Pay the $300 filing fee.
2. Obtain an EIN:
   • Apply through the IRS website. An EIN is required to file Form 2553 and open a business bank account.
3. Draft an Operating Agreement:
   • While not required by Texas law, this document helps clarify member roles and profit distributions.
4. File IRS Form 2553 to Elect S Corp Status:
   • Submit the form within 75 days of the start of the intended tax year.
   • All members must consent to the election.
5. Comply with Payroll Requirements:
   • Set up payroll if you’re paying yourself a salary.
   • File appropriate federal employment tax forms (e.g., 941, W-2s).
6. File Annual Franchise and Public Information Reports:
   • Due May 15 each year, regardless of S Corp status.
7. Maintain Corporate Formalities:
   • Keep records of major business decisions.
   • Conduct annual meetings and record minutes, if desired for formality.

If you need help setting up a Texas LLC with S Corp election, you can find experienced attorneys on UpCounsel who specialize in business formation and tax strategy.

Frequently Asked Questions

1. Can a single-member LLC in Texas elect S Corp status? Yes. A single-member LLC can elect to be taxed as an S Corporation by filing Form 2553 with the IRS, as long as it meets eligibility criteria.

2. Do I need to file anything with Texas to elect S Corp status? No. The S Corp election is made at the federal level using IRS Form 2553. Texas does not require a separate state filing for this.

3. What happens if I miss the 75-day deadline for filing Form 2553? You may still qualify for late election relief if you can show reasonable cause for the delay. Consult a tax advisor or attorney to help with this process.

4. Do I have to pay franchise tax if I elect S Corp status? Possibly. Most small businesses in Texas do not owe franchise tax due to the “No Tax Due” threshold, but you still must file the report annually.

5. What is the main benefit of an LLC with S Corp election in Texas? The primary benefit is potential savings on self-employment taxes, as S Corps allow for profit distributions that are not subject to FICA taxes.

If you need help with electing S corporation status for your LLC, you can post your legal need on UpCounsel's marketplace. UpCounsel accepts only the top 5 percent of lawyers to its site. Lawyers on UpCounsel come from law schools such as Harvard Law and Yale Law and average 14 years of legal experience, including work with or on behalf of companies like Google, Menlo Ventures, and Airbnb